Goldman Sachs says JPMorgan Chase should be broken up

Goldman says that JPMorgan JPM would be worth as much as 25% more if it were split into different pieces. Goldman advocates a “complete breakup” of the nation’s largest bank, and says the boost in returns from a split would far out weigh the synergies that JPMorgan claims it gets from its current size.

In a report released on Monday, Goldman’s lead banking analyst said that JPMorgan could be broken up into four parts. The biggest of the pieces would include the bank’s branch network, which Goldman says could be worth over $100 billion on its own. JPMorgan’s investment bank would be nearly as large, followed by its commercial bank and an asset management company.

Goldman says that even splitting JPMorgan in two—dividing the investment bank from the traditional bank, returning the company roughly to what was allowed before the Glass Steagall Act was repealed in the early 2000s—would boost the overall value of the current bank by 16%. “Our analysis indicates that even accounting for lost synergies, a JPM breakup would be accretive to shareholders in most scenarios,” wrote Goldman analyst Richard Ramsden in the report.

Banking reform advocates have long called for the nation’s biggest banks to be broken up. The so-called too big to fail problem has received plenty of attention since the financial crisis. Many believe the government in late 2008 was essentially forced to bail out the nation’s banks in order to avoid a deeper recession. Some think new regulations have addressed the too big to fail problem. Others, including some prominent bankers, think big bank break ups would make sense. Sandy Weill, who was the CEO of Citigroup when it became the first of the nation’s modern mega-banks, now says he believes breaking up the large banks makes sense.

But this is the first time Goldman has called for a bank bust up. Ramsden says the new capital requirements for big banks proposed by the Federal Reserve in early December make now a good time to consider such a split. Under the proposed Fed rule, JPMorgan, because of its size, would be required have enough capital to cover 11.5% of its riskiest assets. That could be as much as 2 percentage points more than even its closest rivals, like Bank of America BAC, Wells Fargo WFC, Citigroup C, or even Goldman GS. What’s more, Ramsden says a break up makes more sense for JPMorgan because, unlike some of its rivals, its individual businesses are strong enough to stand on their own. The bank is partly a victim of its own success, he says.

JPMorgan declined to comment on the report. The bank’s shares rose just 7% in 2014, half as much as BofA’s shares and significantly trailing the performance of Well Fargo’s stock, which was up more than 20%.

In the past, JPMorgan has said that it brings in as much as $15 billion in revenue because it is able to cross-sell its services among its divisions. But Ramsden contends that most of those synergies aren’t real. As much as half of JPMorgan’s “disclosed revenue synergies” are within the investment bank or the commercial bank, and not really across divisions, he says.

Ramsden admits that breaking up JPMorgan comes with its own set of operational risks. Estimates of what companies would be hypothetically worth if they were broken up often yield higher figures than what a company currently trades for in the real market.

Goldman, for instance, ranks as the fifth largest bank in the nation by assets, with $868 billion. (JPMorgan had just over $2.5 trillion in assets at the end of the third quarter of 2014, making it No. 1.) So, here’s my proposal: Break up Goldman into three divisions: investment banking, private equity, and asset management. Do that, and, based on my back-of-the-envelope math, and using Ramsden’s model, Goldman would be worth at least $100 billion, or nearly 18% more than what its shares are trading at today. And that’s before any benefit Goldman gets from the fact that its divisions would be smaller and therefore required to hold less capital by the Fed. It’s time to break up Goldman Sachs!

JPMorgan Chase may need another $20 billion after Fed sets new rule

JPMorgan Chase & Co. needs to find more than $20 billion to beef up its capital reserves by 2019 to meet new regulations issued by the Federal Reserve.

The New York-based bank already faces the highest capital surcharge under international requirements, and that’s getting even more stringent after the Fed set out a plan Tuesday to increase surcharges on the eight largest U.S. banks.

The additional buffer is intended both to reduce the risk of a bank failure, and the need for publicly-funded bailouts if a major bank does fail. The new range of surcharges reflects the authorities’ desire to make sure that banks that are “systemically important” are even safer than smaller ones, and thus end the concept of “Too Big To Fail”.

The Fed didn’t outline specific requirements for each bank, but said it would raise its capital requirements anywhere from 1% to 4.5% of risk-adjusted assets. In order to meet the new demands, the eight U.S. banks would need an additional $21 billion, according to the Fed.

According to comments by the central bank’s Vice Chairman Stanley Fischer, JPMorgan JPM will likely be the hardest hit by these new requirements. It is “the firm that is actually going to have to come up with more capital,” said Fischer. He added that one bank would need another $22 billion in reserves, a “pretty impressive shortfall.”

JPMorgan has about $163 billion in top-quality capital, or 10.1% of risk-weighted assets, as of the end of the third quarter. The levels meet the standard outlined by the Basel Committee on Banking Supervision. In order to meet the new 11.5% ratio indicated by the Fed for the highest-risk group, the bank would need more than $20 billion in additional capital.

While the bank is still reviewing the Fed’s proposal, JPMorgan is “well capitalized and intend to meet their requirements and time frames while continuing to deliver strong returns for our shareholders,” according to a company spokesperson.

On current trends, the bank should easily be able to reach the new threshold just by retaining earnings. It has been churning out over $5 billion a quarter in net profit this year as the economy returns to health.

Marianne Lake, JPMorgan’s chief financial officer, addressed the Fed’s updated regulation at an investor conference in New York Wednesday. She said the bank wouldn’t have to make “meaningful change” to its corporate and investment bank and will be able maintain its payout to investors while it meets the new requirements.

The Fed set a 2019 target for compliance. The committee said that “almost all” of the banks already meet the new standard, and all the companies are on the right track to succeed by the end of the 2016 to 2019 transition period.

The other banks that are subject to the new requirement are Citigroup C, Morgan Stanley MS, Bank of New York Mellon BK, Bank of America BAC, Wells Fargo WFC, Goldman Sachs GS and State Street STT.

The Financial Stability Board, which coordinates the global regulatory response to the 2008 financial crisis on behalf of the Group of 20 major economies, said that Global Systemically Important Banks, or G-SIBs, should in future have to hold loss-absorbing capital equivalent to between 16%-20% of their total assets, adjusted for risk.

That’s more than double the 8% ratio that was prescribed in the so-called “Basel III” accords in 2011, which are being phased in around the world by 2018. The actual ratio required may even be higher than the basic range of 16%-20% range, as the plan allows national regulators to add on further capital charges if they deem it necessary.

The scale of the new requirements reflects, in part, the fact that regulators have largely failed to crack the legal and political problems of resolving a global bank (such as Lehman Brothers was), if its collapse leaves a trail of creditors in numerous jurisdictions, all with competing claims on its assets.

The new requirements would hit 30 banks that the FSB considers G-SIBs. They include JP Morgan Chase Inc. JPM, Citigroup C, Goldman Sachs , Morgan Stanley MS, State Street STT and Wells Fargo Inc. WFC, as well as all of the largest European and Japanese banks, plus two Chinese lenders.

Mark Carney, chairman of the FSB and governor of the Bank of England, told the BBC Monday that the pre-crisis system, which forced governments to carry out multi-billion dollar bail-outs to avert financial disaster, had been “totally unfair.”

“The banks and their shareholders and their creditors got the benefit when things went well,” Carney said. “But when they went wrong the…public and subsequent generations picked up the bill–and that’s going to end.”

Banks have complained ever since the Basel III accords that stringent new capital requirements would make it difficult for them to turn a profit, but such claims have lost credence as bank profits–especially in the U.S.–have rebounded with the economic upturn.

The new rules wouldn’t necessarily mean that banks will have to issue floods of new shares that would dilute their existing shareholder base. More likely is that banks–which typically depend to a far greater extent on bonds than equity to finance themselves–will have to rely less on “senior” debt, and switch more of it for “subordinated” debt that regulators can write down to zero if a bank’s losses exceed its equity base.

The FSB said it expects that banks will be able to use such ‘bail-in-able’ debt securities to meet at least one-third of the requirement.

Under the FSB’s proposals, banks would have until 2019 to meet the requirements. If they fail to do so, then regulators could restrict or ban bonus payments or dividends until a bank met them.

The final terms of the requirement will be fine-tuned after feedback from the banks themselves, and from a ‘Quantitative Impact Study’ in early 2015.

Study: QE is no welfare program for big banks

If there’s one thing that both the left and right in America can agree on, it’s that the U.S. government is the thrall of Wall Street, handing out freebies to big banks whenever it gets the chance. And the king of all Wall Street welfare, according to these critics, is quantitative easing. Take, for instance, libertarian magazine Reason excoriation of central bank bond purchases back in 2012, when the current program was announced:

Quantitative easing … is fundamentally a regressive redistribution program that has been boosting wealth for those already engaged in the financial sector or those who already own homes, but passing little along to the rest of the economy.

These sentiments were echoed by left-leaning publications like The Daily Kos, which referred to QE as “corporate welfare” for big banks. But a new study released Wednesday by the International Monetary Fund, which the authors claim is “the first to provide a comprehensive assessment of unconventional monetary policies on the soundness of the banking sector,” argues that quantitative easing likely hurt the profits of banks, if it had any effect at all on their bottom lines.

The paper shows that while the QE program reduced banks funding costs and increased the value of some bank assets it hurt banks’ profitability by lowering the amount of interest these firms could charge on a range of products. The fact that Fed actions to reduce long-term interest rates has led to a flattening of the yield curve has made it particularly difficult for financial institutions to make money when the business of banks, put simply, is borrowing short-term and lending long-term.

On the other side of the coin, however, the IMF study did find that QE has encouraged banks to increase their risk taking because low interest rates make it easy for banks to avoid removing toxic assets on their balance sheets. According to the report’s authors, “When interests rates are very low, banks can rollover existing loans or even extend new loans to nonviable firms at nearly zero cost.”

This makes sense. What is the point of lowering interest rates if not to motivate lenders to take risks they otherwise wouldn’t have taken? If you believe that a central bank ought to manage interests rates and institute policies that balance promoting growth and limiting risk, well, QE is a natural extension of that principle.

The Fed has several tools at its disposal to rein in risk—like its stress tests, the review of large banks’ “living will” plans, and other regulations—so it can accept that QE might increase risk taking as long as it also boosts growth, particularly at a time when there is a lot of slack in the economy.

Fed, FDIC tell banks their bankruptcy plans ‘are not credible’

U.S. regulators have asked a group of 11 banking giants to resubmit plans, or living wills, meant to ensure that they could enter bankruptcy without triggering a massive fiscal crisis.

On Tuesday, the Federal Reserve and the Federal Deposit Insurance Corporation said they had identified “specific shortcomings” in the plans submitted by each of the banks and that they “are not credible and do not facilitate an orderly resolution under the U.S. Bankruptcy Code.” The strong wording came in notes released by the regulators commenting on the second drafts of the banks’ bankruptcy plans following their initial submissions in 2012.

The banks were told that they need to make “significant progress” before another wave of submissions are due July 1 of next year (Bloomberg noted that the banks actually submitted their third round of plans earlier this year, though the government’s response on Tuesday relates only to last year’s submissions).

The 2010 Dodd-Frank Act empowered the Fed and the FDIC to require large financial institutions to submit bankruptcy plans for evaluation. The idea is to save taxpayers from having to bail them out of a crisis.

The regulators did not identify which specific issues each bank’s plan had. But in general, they noted in their release that the banks need to establish less complex legal structures and develop operational structures that can better handle a crisis. The agencies added that the banks’ plans make unrealistic “assumptions about the likely behavior of customers, counter-parties, investors, central clearing facilities, and regulators.”

The 11 banks in the first group of filers are Bank of America, Bank of New York Mellon, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street Corporation and UBS.

As Fortune has reported, the Government Accountability Office recently put out a report showing that the perception, among lenders, of the largest banks being “too big to fail” has declined, but not been eliminated, in recent years.

Too big to fail is dead, but not as dead as it used to be

Last week, the Government Accountability Office released a long-anticipated report on whether the nation’s largest banks get a subsidy for their bigness. A large subsidy would imply that the government would bail out the mega-banks if they get in trouble again.

So, will Washington come to the rescue once again? No, says the GAO. Although the study did find that big banks do receive a borrowing advantage based on the fact that they may be “too big to fail.” But that advantage is not very large, and it’s a lot smaller than it was a few years ago. That suggests that Dodd-Frank, along with other bank reforms passed in the wake of the financial crisis meant to end too big to fail, are working, mostly.

Plenty of journalists and commentators hadstrongfeelings about the report. Matt Levine of Bloomberg argued that while the advantage is small now, that’s because few banks are about to fail. It’s like insurance. It’s only worth something when you need it.

Edward Kane of Boston College, in testimony to the U.S. Senate, said that the GAO, and pretty much everyone else, is looking at the wrong figures. Instead of looking at how much less big banks pay to borrow, Kane said we should really be looking at how much more investors pay for shares in these banks. Shareholders, after all, are the ones who really get saved in a bailout. And because they are the first ones to be wiped out in a failure (bank debts might live on), they are likely the most sensitive to whether a bank will get bailed out. Call it the too-big-to-fail stock premium.

How big is the too-big-to-fail premium? Zero. Actually, it’s less than zero. It’s a negative $213.7 billion.

Here’s how I figured that out. I downloaded data on the nation’s 312 largest publicly traded banks. At the top of my list was JPMorgan Chase JPM, with $2.5 trillion in loans, investments, and other assets. The smallest on the list was Baylake Corp BYLK. It has has 22 locations and is based in Sturgeon Bay, Wisc. Its motto: “Helping build the good life.”

I then separated the list into the big banks, like JPMorgan, that are subject to the Fed’s annual stress tests, from the rest, which include some fairly big banks, but also plenty of Baylake-sized lenders. I calculated the average return on equity for the two groups and the average price-to-book-value. A number of studies have shown that investors will pay higher price-to-book values for companies with higher ROEs.

If investors were willing to pay more for big banks that yielded the same returns they would receive from small banks, then you could conclude that investors were paying for their bigness and the prospect of government protection.

But that’s not what I found. Investors don’t appear to be paying for bigness. In fact, they appear to be penalizing big banks for being big. In all, the nation’s largest banks get a nearly $214 billion penalty for their size. For context, JPMorgan has a market cap of $212 billion.

To be sure, there are a few reasons you might not want to take my findings, well, to the bank. First of all, the GAO spent nearly a year on its study, and it ran 42 different models factoring data from seven different years. I did my study in a few hours on a Monday morning. I used one, poorly organized, excel (!) spreadsheet.

Second, I used the same methodology to come up with my figures that I used to compute that Wal-Mart WMTcould afford to give its workers a 50% raise and not significantly hurt its stock price. Some people, particularly Wal-Mart, have raised questions about my math. But I stand by it.

What’s more, most investors don’t trust bank balance sheets, particularly big bank balance sheets. There are still plenty of bad loans, which probably understates what investors are willing to pay for shares in these banks. Take out those bad loans and the price-to-book of the big banks would rise. So would the return on equity figures. The combination of those factors could erase, or at least shrink, the amount investors are underpaying for big banks.

Lastly, looking at the stock market might be a really bad way to measure too big to fail. Boston College’s Kane is really the only one advocating it should be measured this way. And when I called him to tell him that I found basically the opposite of what he suggested I would find, he said I had looked at the wrong thing. Then again, what he suggested I look at didn’t really prove his point either.

Instead, what I found backs up the GAO’s report. Investors don’t believe there is an implicit government guarantee for the big banks. If anything, they believe there is is an implicit penalty.

The one point where my numbers disagree with the GAO study: the big bank penalty has been shrinking. It has averaged just over $700 billion over the past half decade. So it appears that the response to the financial crisis and Dodd-Frank and other banking reforms have made investors more likely to expect bailouts, even if they are still not sure they will come. Too big to fail is dead, but, I guess, not as dead as it was a few years ago.

For largest banks, “too big to fail” perception is faded, not forgotten

Big banks today are even more gargantuan than before the financial crisis. But their status as “too big to fail” is weakening, at least according to a new government report.

The report from the Government Accountability Office, a government watchdog agency, says that recent regulatory reforms like the Dodd-Frank Act have effectively “reduced but not eliminated the likelihood the federal government would save the biggest banks from failure. prevent the failure of one of the largest bank holding companies.” The reforms hold the biggest financial firms to a higher level of accountability while increasing their costs and reducing risks, according to the GAO.

In creating the report, the GAO compared funding costs for the biggest financial institutions to those for smaller banks. If the assumption among lenders is that the U.S. government would rather bail out the biggest banks rather than allow them to fail, then that would drive down their costs. The largest banks had lower borrowing costs than their smaller counterparts during the financial crisis between 2007 and 2009. But that the gap has since narrowed because lenders are more uncertain whether the government would bail out the big banks.

The report will likely be held up by large financial institutions as proof that they no longer receive the same level of preferential treatment because of the view that they “too big to fail.” However, smaller banks can point to the reports’ claim that their disadvantage when it comes to lender perception has yet to be eliminated completely.

Yellen testimony shows too-big-to-fail is still a very big problem

Elizabeth Warren has always been a fierce critic of big banks. But the Massachusetts Senator brought her calls for action against the largest financial institutions to a new level on Tuesday, when she argued in a Senate hearing featuring Federal Reserve Chair Janet Yellen that the central bank should use authority already granted it by Dodd-Frank legislation to force big banks to slim down.

For the past three years, the largest banks and systemically important non-financial firms have been required under Dodd-Frank to submit blueprints to the Federal Reserve and the FDIC that show how the companies could quickly be unwound in a bankruptcy process that wouldn’t involve public bailouts and would avoid the collapse of the financial system.

Warren, however, is skeptical that the largest banks, which are much bigger today than they were before the financial crisis, could be quickly unwound at all, given their size and importance. Warren argued that the bankruptcy of Lehman Brothers, the investment bank whose failure helped cause serious turmoil in financial markets in 2008, took more than three years to work itself through the courts even though it only had $639 billion in assets. Compare that to the $2.9 trillion in assets that JPMorgan, America’s largest bank, has today. Said Warren:

“JPMorgan has 3,391 subsidiaries … more than 15 times the subsidiaries Lehman had when it failed. JPMorgan has filed resolution plans in the past three years, and the Fed has not rejected them as not credible.”

In other words, Warren is wondering what many Dodd-Frank critics have asked in the years since the passage of the bill: How exactly will Dodd-Frank reforms prevent another round of bailouts during the next financial crisis?

Nobody from the government has explained to the public in clear language how a resolution of a firm the size of JPMorgan could proceed without a government backstop, given that no firm anywhere near its size and complexity has ever been unwound quickly enough to avoid needing a bailout.

Warren believes that the banks must be forced to downsize in order to be simple enough to be unwound during the next financial crisis, and she believes that the Fed should use its powers to reject these banks’ living wills and force them to sell off assets. “The statute is pretty clear here,” Warren said. “It’s mandatory that these plans be submitted each year and that each year you determine whether these plans are credible. I guess what I’m asking here is, have they ever gotten to a plan that you can say with a straight face is credible?”

Yellen’s response wasn’t at all reassuring for those who believe that the biggest banks are far too big. She believes that the production of living wills is an “iterative process” that should be produced with banks and regulators working together to make sure there’s an orderly way to resolve too-big-to-fail banks. She defended the collaborative nature of the process by saying that these living wills were “extremely complex documents” that run to “tens of thousands of pages.”

Of course, one could reasonably wonder how it would be possible to unwind an institution quickly (the FDIC usually unwinds small failed banks over the course of a weekend to avoid disrupting markets) when the living will along stretches beyond 10,000 pages.

For Warren, the answer is clear: force the banks to get smaller. “There are very effective tools that you have at your disposal if these plans aren’t credible,” Warren admonished the Fed chair. “Including forcing these financial institutions … to liquidate some of their assets.”

Sheila Bair: Why I recommend Tim Geithner’s book

FORTUNE — In his new book, Stress Test, former Treasury Secretary Tim Geithner says nice things about me, kind of. For the most part, he fairly recounts our disagreements during the 2008 financial crisis and its aftermath. If you share my skepticism of the bailouts and their generosity, you will think well of the positions I took. If you share his world view that we were justified in throwing trillions at the big banks to “save the system,” you will not. Wherever readers come out, Tim’s book has reinvigorated a much-needed debate about whether our financial system should be based on a paradigm of bailouts or on one of accountability.

Though the vast majority of Americans favor the latter, Washington’s love affair with big finance continues. Regulators and politicians may spout a good line about ending “too big to fail,” but their actions speak louder than their talking points. Financial reform has been tepid. The hard work to force mega-banks to raise more capital, replace their unstable short-term funding with long-term debt, and simplify their legal structures is at best, half-done.

But who can blame the regulators for being timid when members of both parties in Congress seem to value campaign contributions over system stability? Indeed, as I write this, the House is planning a hit-job hearing against Treasury’s Office of Financial Research (OFR) for daring to raise questions about risks posed by large asset managers. This is reminiscent of the intimidation tactics used by the derivatives industry more than a decade ago to beat back Brooksley Born when, as Chair of Commodity Futures Trading Commission, she suggested that derivatives markets needed oversight.

At least Tim is honest about his acceptance of mega-banks and his disinterest in ending too-big-to-fail. But what’s troubling is his failure to acknowledge the inherent instability created when Wall Street thinks it has a giant put on Uncle Sam. He accepts the risks of moral hazard when it comes to bailing out homeowners, but not the mega-banks. He almost naively assumes that the titans of Wall Street can somehow rise above the temptation to take outsized risks when they know the government will always be there to bail them out. Yet, when it comes to homeowners, Tim worries about the moral hazard government relief efforts create. Indeed, he justifies his limited efforts to help homeowners, in part, by saying that he didn’t want to reward the behavior of those who knowingly got in over their heads.

I agree with Tim that there will always be financial cycles and a need for government interventions. But the point of those interventions should be to stabilize the system for those in the real economy who rely on banks for payment processing and credit — the depositors and borrowers. The goal should not be to bail out those who manage banks and invest in them — and caused the problem in the first place. Tim’s justification of the bailouts is based on a false dilemma: that our only choices were either to do nothing or to pursue the over-the-top measures which we did.

To be sure, the risk of bank runs is real in a financial panic. If an institution has trouble funding itself, that can have a severe impact on its ability to keep lending. But only a financial institution’s short-term borrowing “run.” These include uninsured deposits, and sources such as repos and commercial paper that need to be continuously renewed. Long-term debt and equity can’t “run” — those investors are stuck and should bear the risks of their investment decisions. There is little reason to bail them out if stabilizing the system is the goal. Similarly, you don’t need to protect the jobs and bonuses of dunderheads at places like AIG AIG and Citi C who got their institutions into trouble. Indeed, markets generally look favorably at replacing bad management and withholding bonuses from people who caused losses for the companies where they worked.

On his book tour, to explain the need for bailouts, Tim has used a clever analogy of a pilot trying to land a plane that is on fire and in the back, sit the terrorists who started it. He argues that the pilot can’t leave the cockpit to put them in handcuffs. He first has to land the plane. The problem with this analogy is that the plane landed at the end of 2008. And let’s face it, instead of handcuffing the terrorists, we escorted them to the executive lounge.

The reality is that by 2009, the financial system had stabilized. For better or worse, trillions in government support had been provided, including $700 billion in TARP funds. At that point, there was no excuse not to require Citi to restructure and downsize, to force banks to shed their bad assets, to require wide-scale restructurings of troubled mortgages, and yes, to put a few people in jail. This has nothing to do with vengeance. It’s just good economics. If people aren’t held accountable for their behavior, they will commit the same offenses. If banks don’t clean up their balance sheets, they won’t go out and lend. People in over their heads on mortgage debt cut back on other spending. Millions of underwater mortgages impede labor force mobility and create “shadow inventory” which prevents the market from clearing.

Tim, however, discounts bailout criticisms as Old Testament justice. He doesn’t buy the counter-economic arguments, and on that, we will never agree. But unlike some college students these days and their attitudes toward commencement speakers, I don’t mind listening to people whose views differ from mine. So I recommend his book. It is well-written and full of revealing personal anecdotes. Tim’s charm and wit come across, page after page. He tells of one story when he was out boating off Cape Cod and saw a couple whose sailboat had capsized. They were hanging on to the hull for dear life. He swam over to them and convinced them to swim to his boat, only to discover that they were weak swimmers and couldn’t handle the current. Fortunately, they made it back to their boat and were eventually rescued. Tim wryly characterizes this as an early lesson in crisis decision-making. (It might also suggest an early propensity to bail out people when they really should be left to their own resources.)

While an enjoyable read, Tim’s book is also a warning. As much as he is trying to justify the decisions he made and actions he took during the crisis, I sense he is also trying to prep the public for future bailouts. And with this message, I fear, he is reflecting the unspoken views of many on Wall Street where he is now employed: The system is still unstable, there will be another crisis, and yes, they will need to be bailed out again. Of course, Wall Street titans would like bailouts to be new paradigm — after all, they are so much easier than trying to reform the system and hey, they made money last time!

The problem is, when Wall Street blows up, the rest of us suffer. The cash profits from the bank bailouts are poor recompense for the millions who lost their homes and their jobs, to say nothing of taxpayers and the huge risks the government took with their money. For these things, the public will never be adequately compensated.

I guess I would feel better about Tim’s rationalizations of the bailouts if I thought he was more committed to avoiding them in the future. But instead of openly and vigorously advocating for meaningful financial reform, he seems to think we have pretty much done all we can or should do. I think we should apologize for the bailouts. He wants to be thanked for them. But if we glorify regulators when they bail out the industry, while savaging them when they try to regulate it, what kind of system will we have?

Sheila Bair was Chairman of the Federal Deposit Insurance Corporation from 2006-2011 and is the author of the New York Times best-seller, Bull by the Horns: Fighting to Save Main Street from Wall Street and Wall Street from Itself.

Why taxpayers may now be off the hook when a big bank fails

Is “too big to fail” over? Believe it or not, it just might be. Even though the Dodd-Frank financial reform law banned future taxpayer bailouts of banks, the public remains skeptical. Given the size and complexity of the largest banks, it is difficult to imagine how the government could run them through an orderly bankruptcy process. Even if the regulators had the political will to do so, how could they possibly avoid systemic disruptions? Here’s how.

Under its new Dodd-Frank mandate, the FDIC has unveiled an innovative strategy to handle a megabank failure. It’s not an easy challenge. In his book The Great American Bubble Machine, Matt Taibbi described Goldman Sachs as a “vampire squid.” I’m not sure about the blood-sucking part, but the metaphor holds in describing the legal structures with which regulators of megabanks must struggle. Visualize them as big heads sitting atop a morass of arms and sucker-covered tentacles, drifting in an inky cloud of opacity. The head is the “holding company,” the life-blood source. It issues equity and debt to the public and funnels the money down to its tentacles below. There are thousands of those tentacles — discrete legal entities frequently created not for operational efficiency but to avoid some tax, regulatory, or accounting rule. Each business line, be it investment bank, derivatives dealer, or commercial bank, is supported by hundreds of the same intertwined legal entities. You can’t detach them without damaging other parts of the franchise.

In its new plan, the agency will be able to take control of the holding company — and become the new owner. As the temporary owner, it will keep the healthy arms alive in one or more “good banks,” while putting the megabank’s former shareholder and creditor interests into a government-controlled receivership. Losses will be fully absorbed by the holding company’s shareholders and unsecured creditors. Taxpayers will not be at risk of loss.

This strategy will allow the FDIC to leave healthy foreign subsidiaries open for business. The challenge is that most countries won’t allow banks owned by foreign governments to operate within their borders. By maintaining viable foreign subsidiaries, the FDIC hopes to avoid their seizure by foreign authorities and ensure that non-U.S. trading partners keep performing on their contractual commitments. The success of the FDIC’s strategy will, of course, depend on the willingness of foreign jurisdictions to respect its authority as the megabank’s temporary new owner. The agency has been working with the Bank of England, whose cooperation will go a long way to ensure the success of the strategy, in that more than 80% of U.S. megabanks’ foreign operations are subject to the jurisdiction of the U.K.

Short term this strategy can work, but it will be costly and difficult. Longer term, regulators must require the megabanks to simplify and provide better market disclosure of their legal structures. The speed with which the FDIC can restructure them as good banks and return them to private-sector ownership will be greatly enhanced if their business lines and foreign operations have already been organized into a rational number of legal units that can be easily detached. At least two large banks, Santander and HSBC, organize international operations this way, so it can be done. Regulators must also require holding companies to issue enough equity and unsecured debt to absorb losses should they fail.

Not convinced that bailouts are over? Well, if you are swimming with one of the squids as an investor, do you want to take the chance? Perhaps if one of these giants gets into trouble, the government will blink and throw you a life jacket. But given the strong language in Dodd-Frank banning future bailouts, I doubt it. If you own stock or subordinated debt, you will probably be wiped out. If you own bonds, you will take a big loss. So be a prudent investor, and do your homework. If you still don’t understand the risks, get out of the water.

–Fortune contributor Sheila Bair is former chair of the FDIC and author of New York Times bestseller Bull by the Horns.